It seems that just as we resolve one debt crisis, another is waiting in the wings. Of course, the easy credit that resulted in the sub-prime mortgage debacle was the root of the 2008 financial crisis. The latest chapter is the ballooning student loan debt estimated by the Federal Reserve to be $1.52 trillion and growing by $29 billion per quarter. Saddled with this encumbrance, many millennials are financially strapped and unable to purchase a home or car let alone spend on furnishings and home improvements. Some have even delayed marriage and having children. For many millennials, the repayment of student loans represent their top financial priority.
Furthermore, many borrowers are simply unable to keep up with payments. In data released by the Brooking Institute last October, they estimate that :
- Nearly 40% of all borrowers may default on these loans by 2023
- 10.7% are already delinquent by 90 days
- $31 billion is seriously delinquent
Unlike other types of loans, consumer protection safeguards do not provide relief to borrowers of private student loans. They are the only type of loan that can almost never be discharged in bankruptcy. Even death cannot eliminate student debt. If there is a co-signor on a loan where the borrower has died, the lending institution may legally demand full and immediate payment. Federal loans, however, can be discharged at death.
Unfortunately, the institutions in the best position to help alleviate this crisis actually exacerbate it. Federal law requires all colleges who participate in the student loan program to ensure that the default rate for borrowers is less than 30% for 3 consecutive years or no more than 40% in any single year. If colleges fear they are in danger of breaching this threshold, a common tactic they employ to maintain their eligibility is to encourage tardy borrowers to defer their repayments until a later date. Of course, the result of this delay can be detrimental to borrowers as it increases the accrued interest on the loan. The Federal government also seems to understate the severity of this problem. Last month, Seth Frotman, the student loan ombudsman for the Consumer Financial Protection Bureau (CFPB) resigned. In his announcement, Frotman expressed his view that the bureau had abandoned consumers in favor of the most influential financial companies in America.
Not all the news is dire. There are strategies that borrowers can employ to reduce this financial burden. In most cases, borrowers are able to minimize interest charges over time, significantly reduce monthly payments, or receive outright forgiveness on a portion of their loan balance. The correct approach can only be determined by assessing a multitude of factors including the borrowers’ career path, total loan balance, earnings probability, and specific financial goals.
For borrowers with relatively high current or future income and a reasonably low debt balance, it often makes sense to use a more traditional debt repayment strategy. If affordable, they should minimize interest charges over time by paying off their debt as quickly as possible and prioritizing the repayment of higher interest loans. This approach seeks to avoid the capitalization of interest and reduce the total amount spent toward paying down their debt.
If a borrower chooses this strategy, they should consider a private consolidation, which replaces multiple loans (federal and/or private) with just one loan at a single interest rate. This is most beneficial to borrowers that are deemed creditworthy, as they will likely be able to reduce their interest rate. However, once a private consolidation is completed, borrowers become ineligible for income-driven repayment plans and the Public Service Loan Forgiveness Program, which we will delve into below. Less creditworthy borrowers likely will not benefit from a private refinancing, so they may want to look into a federal consolidation, which simplifies the repayment process and establishes eligibility for the aforementioned federal aid programs. If a borrowers’ financial situation changes, the additional flexibility provided by these programs can be valuable. It should be noted that the new interest on a federal consolidation loan is calculated as the weighted average of the rates on the loans being consolidated, rounded up to the nearest 1/8th of a percent.
Student loan borrowers with low earnings potential and a high student loan balance are usually best suited to enter into an income-driven repayment plan. Unlike traditional debt where payments consist of principal and interest, income-driven repayment plans set monthly student loan payments as a percentage of the borrowers’ discretionary income. Depending upon which plan a borrower qualifies, payments range from 10%-20% of discretionary income and extend for up to 20 or 25 years. At the expiration of this period, any remaining loan balance is forgiven. It is important to note that any amount forgiven is categorized as taxable income. Therefore if a borrower anticipates any forgiveness, they need to be prepared to pay a potentially significant tax bill in the future.
Borrowers who are employed by government or a not-for-profit organization typically earn less than their private sector counterparts and should seek forgiveness through the Public Service Loan Forgiveness Program. The program, which began in 2007, forgives the remaining balance on a borrowers’ loans after they have made 120 qualified monthly payments under an approved repayment plan while working full-time for an eligible employer. Any of the income-driven repayment plans can be used to make these qualifying monthly payments, and forgiveness may be granted after just 10 years.
For borrowers of student loans who are in despair, there may be relief. In response to the demand to develop expertise that can deliver solutions to stressed borrowers, a new course of study has emerged. The Certified Student Loan Professional (CSLP) designation recognizes qualified student loan advisers. Stephen earned this designation this past summer and is prepared to advise those borrowers who seek guidance. This is a new service we offer and look forward to working with you, your friends, relatives, business associates, etc. who have been searching for answers to this daunting problem.